This blog gives you the latest topical news plus some informal comments on them from ShareSoc’s directors and other contributors. These are the personal comments of the authors and not necessarily the considered views of ShareSoc. The writers may hold shares in the companies mentioned. You can add your own comments on the blog posts, but note that ShareSoc reserves the right to remove or edit comments where they are inappropriate or defamatory.

Competition in the Audit Market

I attended a “roundtable” event at the Financial Reporting Council (FRC) on Monday. It was primarily a discussion of audit market competition and how to improve it, with private investors attending. But as I said at the meeting the key issues in the audit market are the quality of audits and the accountability of auditors. Too many blatant frauds go undetected by auditors, and they avoid any responsibility for their errors. Being able to avoid accountability for their failings has resulted in declining audit standards over the last few decades. The Caparo legal judgement is one big reason as it prevents shareholders suing auditors for their failings. It needs overturning.

These thoughts were echoed by other speakers at the meeting although the FRC made clear that their focus is on quality.

The Kingman review of the FRC was critical of the audit sector and its regulation by the FRC while the Competition and Markets Authority (CMA) is undertaking a review of the market for audit services which is dominated by the big four audit firms.

Would improved competition for audit services improve the quality of auditing is one key question? Or simply lead to a race to the bottom as price competition was increased? Alternatively could quality be improved by improving the work of audit committees and how they select auditors? All of these questions were discussed but no specific conclusions reached.

One proposal to improve competition is to enforce “joint” or “shared” audits where all audits of larger companies would require the involvement of more than one audit firm. This might enable smaller audit firms to become more experienced and more credible to take on larger audits it is argued. But as I said in my response to the CMA consultation: “ So far as investors are concerned, joint and several liability would be a positive advantage to ensure audit quality in theory. But in practice as auditors avoid liability for most failings, it might not matter a great deal”.

I do not see how joint or shared auditing will improve the quality of audits or necessarily improve competition either. An alternative suggestion that there should simply be a cap on the market share of any one audit firm seems a better and simpler solution to the competition issue.

Apparently according to a report in the FT, audit firms have been lobbying hard to retain the status quo. The FT reported the comments of Will Hayter, a director of the CMA that those in the industry should not doubt the CMA’s resolve to go “from four to more” [audit firms].

Improving competition is undoubtedly of benefit even if it just avoids the risk of one of the big four collapsing (as happened with major audit firm Andersen a few years ago after reputational damage and criminal charges over the Enron fraud). But shareholders major concern is improving the quality of audits so that fraud is detected and dubious financial reports are not published; in other words to ensure that published accounts do indeed contain a “true and fair” view of the financial position of a company.

One example of where they might not be was mentioned in the meeting which is the accounts of Burford Capital (BUR) which I have also commented on myself negatively recently, much to the displeasure of Burford holders. All Burford shareholders should read the article by John Dizard published in the FT on the 17th February and entitled “Burford faces long wait over $1bn Argentina claim”. It questioned the valuation of the Petersen legal claim. See https://www.ft.com/content/6debcc05-e368-44b2-bb99-618b7bc0a618 . The key issue is reliance on the management to value the legal claims where any cash arising from the claimed profits based on the valuation of on-going claims may be a long time in coming, if at all.

In summary we need to improve the accounting and auditing standards if investors are to rely on the published accounts of companies. In the meantime investors will need to take a more sceptical view of the accounts of companies and not take them at face value.

The author has no position in Burford Capital.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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